Top Health-Care Stocks; Gilead Not Included

By

Johanna Bennett

January 13, 2015

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In a good year for the stock market, shares of health-care companies did even better. The health-care sector was up 23.3% in 2014, double the return of the Standard & Poor’s 500 and just shy of the 24% gain recorded by the top-performing utility sector.

Will health-care stocks continue to outpace the market?

Barrons.com posed that question, and many others, to Marshall Gordon, the senior health-care analyst at ClearBridge Investments, an asset-management firm owned by Legg Mason (ticker:
LM
). Since he joined ClearBridge in 2008, Gordon has steered our readers toward several winners, including Biogen Idec (
BIIB
) and Centene (
CNC
), which have climbed 660% and 178%, respectively, since he sang their praises to Barrons.com in late 2011. (See Q&A, “2012 Health-Care Winners,” Dec. 13, 2011.) Among his best picks in 2014: Regeneron Pharmaceuticals (
REGN
), which he recommended at $280 a share and now trades at $411.

Granted, the health-care sector has been helped along by a stiff tailwind in recent years, thanks to mergers and acquisitions, a productive research pipeline, new blockbuster drugs, and the benefits of the Affordable Care Act.

In 2015, investors will need to be more selective, says Gordon, predicting that across-the-board gains will wane. Investors, he says, will need to look for companies with good news on the horizon that is not yet reflected in valuations.

“There is sustainable growth to be found,” he says. “The sector may look expensive, but this valuation can be sustained.”

Here are some excerpts from our recent phone conversation.

Manager’s Bio

Name:

Marshall Gordon

Age:

41

Title:

Director and senior health-care analyst, ClearBridge Investments

Education:

B.S. in finance, University of Pennsylvania; M.B.A., University of Chicago

Hobbies:

Crossword puzzles and cooking

Barrons.com:Health care was one of the best--performing sectors in the S&P 500 in 2014. Will it outperform again in 2015?

Gordon: I don’t think we’ll see the sector outperform to the same extent, or as universally. There are individual companies that can continue to outperform and will help lift the sector, but I don’t expect the same across-the-board multiple expansion that we saw in past years. I am positioning for very specific catalysts to fuel outperformance by specific companies.

Q:Where are you expecting to find your best picks in 2015?

A: Biotechnology, and to a certain extent pharmaceuticals, will continue to be productive sectors both in terms of clinical success, and for investors. I am looking at companies with a number of catalysts on the horizon such as readouts of mid- and late-stage studies for potential mega-blockbuster drugs that are not heavily reflected in the stock’s valuation. That is the type of story I am looking for in 2015.

Q:What are your top stocks picks right now among drug makers?

A: Biogen is attractive given the number of pipeline readouts scheduled for this year. I also like BioMarin. Though the stock has gotten quite expensive, there are many pipeline readouts coming during the next 12 to 18 months that I believe will be mostly positive. I still like Bristol-Myers Squibb (
BMY
). While the stock trades at a record-high valuation, above 30 times forward consensus estimates, if the market for immuno-oncology therapies continues to expand…that multiple is sustainable.

Q:Are there other Big Pharma names worth a look?

A: Absolutely. Pharmaceuticals have had a big turnaround in research-and-development productivity. Investors have gotten paid for a lot of it. But while pharmaceuticals trade at a premium to the broader stock market, the industry’s fundamentals are stronger now than they have been in sometime. We continue to like Roche (
RHHBY
). The Swiss company offers a broad set of biologic assets that continue to grow, as well as pipeline optionality on immuno-oncology.

Q:Let’s talk about Gilead and the market for hepatitis C drugs. In late December, Gilead suffered a selloff after Express Scripts (
ESRX
) struck a deal with drug maker AbbVie (
ABBV
) regarding coverage of a rival hepatitis C therapy that led to a broader industry selloff. Was it warranted and what do you see ahead for Gilead?

A: I have not been a Gilead bull, or as big an optimist about the hepatitis C market as many. I continue to believe that the market won’t be as big or as profitable as is widely expected. Granted, I missed a lot of Gilead’s climb in the past couple of years. But I think Gilead has mispriced Sovaldi and the newer drug Harvoni given that hepatitis C patients are heavily covered by government-funded plans. The fiscal reality is that the government can’t afford to spend $10 billion to $20 billion a year for hepatitis C treatments. So I am not surprised to see insurers and pharmacy benefit managers (PBMs) using price competition to reduce outlays. We are not done with pricing actions in the hepatitis C market.

Q:Will Gilead cut prices for its hepatitis C drugs?

A: I don’t think anybody will cut list prices, but I do think they will cut deals with the PBMs regarding rebates.

Q:Express Scripts started raising heck about the price of Sovaldi shortly after the drug hit the U.S. market. Should the deal with AbbVie have come as a surprise?

A: Not if you were paying attention to what the PBMs and other payers have been saying, specifically Express Scripts, CVS Health (
CVS
) and UnitedHealth’s (
UNH
) Optum division. All three companies have telegraphed plans to use the subsequent entry of rival therapies to control costs.

Q:The medical device sector has enjoyed a rebound in recent months after being out of favor for the past few years. Is it warranted?

A: I have revisited medical device stocks for the first time in a long time, namely the deal-making companies that have taken significant action this year to deploy capital for the benefit of their shareholders. Among those names are Medtronic (
MDT
), which is buying Covidien (
COV
), and Becton Dickinson and its purchase of CareFusion (
CFN
). Right now, I am recommending Becton because I think the CareFusion deal is smart and it will operate the new business well.

Gordon’s Stock Picks

Biogen Idec

BIIB

BioMarin Pharmaceutical

BMRN

Bristol-Myers Squibb

BMY

Roche Holding

RHHBY

Becton Dickinson

BDX

Centene

CNC

Molina Healthcare

MOH

Bluebird Bio

BLUE

Q:Managed care and hospital stocks have delivered big gains since the Affordable Care Act (
ACA
) was proposed and enacted. What do you see ahead?

A: I’m much less excited than I was heading into last year. At the start of 2014, investors were worried that managed care stocks would get hurt by the major changes underway from the ACA. But the sky did not fall and the stocks had a big run last year, with some rising 30% or so. Longer term, UnitedHealth and others are well positioned. I remain focused on names exposed to government-funded markets such as Centene, Molina Healthcare (
MOH
) and Humana (
HUM
). Hospital stocks have also had a great run thanks to Obamacare, but could take a breather in 2015 as the big benefits of Obamacare are annualized and as additional benefits from ACA fail to materialize in 2015.

Q:What other stocks are attractive?

A: I think gene therapy will be a big theme in 2015 and into 2016 if the field finally proves to be the success that everyone has anticipated for so long. There are a number of companies pursuing these types of therapies that could go public in the next year or two. Spark Therapeutics recently filed for its initial public offering. This drug maker could produce positive Phase 3 study results that could lead to a 2016 regulatory approval of the first gene therapy in the U.S. Applied Genetic Technologies (
AGTC
) and Bluebird Bio (
BLUE
) are also in the gene therapy field. Drug makers such as Isis Pharmaceuticals (
ISIS
), BioMarin and Alnylam Pharmaceuticals (
ALNY
) are also ways to tap into gene-based medicine.

Q:Will health care remain an active area for M&A?

A: There were three key drivers of M&A in 2014. Big Pharma, and now Big Biotech, still need new products. Companies with good balance sheets can borrow incredible amounts of money at very little cost. And finally, companies were using so-called inversions to alter their corporate tax bills by moving offshore. The first two drivers remain intact, though I think inversions will be more limited.

Q:When do you expect the biotechnology IPO market to slow down?

A: If only I knew. It’s hard to believe that we could have another year like 2014. The funny thing is that I am still meeting with private companies that I see as good IPO candidates.

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